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Okay, I found out where I was confused. Final Fight had the trans character to protect the American market from violence against women (and replacing it with violence against transgendered men who identify as women), and Streets of Rage 3 had a trans character in Japan and turned it into a non-trans character for America. And also removed a gay character.

But I was totally thinking of the Final Fight one.

Here's a really good timeline of every type of video game depiction of wacky gay characters, well-adjusted serious gay characters, gay bars, and more:

http://en.wikipedia.org/wiki/LGBT_characters_in_video_games

I can't believe I haven't seen this article before.